Question

CH5C HW

1. According to the following table, do the investors believe that the $ will be more or less valuable against the Peso in 3 months?

in $                              per $

Peso                                  0.0687                        14.5560

1 month forward               0.0500                        20.0000

3 month forward               0.0690                         14.4928

6 month forward               0.0556                        17.9856

2. Do the investors believe that the Peso will appreciate or depreciate against the $ in 1 month?

3. What is the 6-month forward premium (discount) for $ in European terms? The 6- month contract is a 180-day contract.

4. Using the same information given in #1, calculate the 1-month forward premium for peso in American terms. The 1- month contract is a 31-day contract.

5. The forward rate between the Peso and $ is F₆($/peso) = 0.0556. If you believe that the peso will depreciate against the $ over the next 6 months, should you take a long or a short position in the peso forward contract?

6. If you take a long position by buying Peso2.5 million forward, and if the spot rate 6 months later is S₁₈₀($/peso) = 0.0501, what would be your profit (loss)?
7. ​​​​​​​

Answer 1

We will have a look at the spot and the forward rates at the PESO/ USD to understand that whether the peso will appreciate/ depreciate against the USD in 1 month.

We see that the spot rate is Peso 14.5560/ $ although the 1 month forward rate is Peso 20 / $ . Here there is increase in pesos per usd so people are of belief that the peso will depreciate against the $ as more pesos will be required to buy 1$ after 1 month.

If the forward exchange rate for a currency is higher than the spot rate, there is a premium on that currency. A discount exists when the forward exchange rate is lower than the spot rate.

the formula is given by , Forward Premium = (F-S) / S * 100 * 365 / N

where F= Forward rate , S = Spot rate , N = No of days

If the answer is negative then its discount or else premium.

6 month forward premium for $ =(17.9856 - 14.5560)/ 14.5560 * 100 * 365 /180

= 3.4296 / 14.556 * 100 * 2.02778

= 47.78%

1 month forward premium for peso =(0.0500 - 0.0687 ) / 0.0500 * 100 * 365/31

= - 0.0187 * 100 * 11.7742

= 22.02%

If it is believed that the peso will depreciate against $ over the next 6 months then we should take a short position in the forward peso contract. This will result into profit.